Are Investors More Accepting of Corporate Unprofitability?

May 17, 2018

 

In CY2017, 76 percent of the companies that went public were unprofitable in the year prior to their launch, the highest level in 18 years (81% of companies that IPO’d during the “dot-com” bubble in 2000 lost money before going public). YTD, 15 technology companies have had IPO’s, of which only 3 firms were profitable. The large number of lossmaking firms that came to market last year, and throughout this year, may not be an outlier. Rather, the number of unprofitable firms going public may be part of an ongoing business tactic. Author Kevin Roose, in his piece “The Entire Economy Is MoviePass Now. Enjoy It While You Can.”, details the growing trend of companies willing to “burn” cash.

Traditionally, speculative investments were taken up by investors with less stringent risk tolerances. In recent years, however, more investors seem to be lenient when analyzing a firm’s current profitability. The “Amazon effect” may be a driver for the change in the threshold of risk investors are willing to accept.

For years, Amazon was an unprofitable venture, and there were concerns about the company’s ability to ever generate positive cash flows. While Amazon was seemingly “burning” through cash, it was using revenue to develop its ecommerce infrastructure and distribution networks. Consequently, it had a strong competitive advantage when the online shopping market significantly expanded. Amazon is now the second largest company in the world (by market cap) and posted a $1.6 billion net profit in 1Q2018. Although the prospect of investing in the next Amazon has caused investors to be more forgiving about a company’s negative cash flows, there are inherent concerns associated with buying the stock of a “cash negative” organization.

MoviePass is a company with industry disrupting potential, but investors have certainly not benefitted from owning shares of the firm. MoviePass’ business strategy involves selling a subscription service to customers for $9.99 per month, allowing them to watch a movie per day at member theaters. MoviePass reimburses the theater the full price of the ticket and profits by customers infrequently visiting theaters. MoviePass’ strategy is highly costly, for both the company and its investors. Shares of MoviePass’ parent company, Helios and Matheson Analytics, have declined by more than 90% since October 2017, 2 months after the company changed its business model and significantly lowered prices. It has been reported that on average, Helios and Matheson loses $21.7 million a month, and that MoviePass lost $98.3 million in the first quarter.   

MoviePass isn’t the only company spending into negative cash flow. Ride sharing company Uber, projected to go public in 2019, lost $4.5 billion last year. Social media firm Snapchat posted a net loss of $3.4 billion in 2017, which was the year of its IPO. Music streaming service Spotify lost $1.5 billion last year. Though disproportionate spending may appear to be the result of poor business models, there may be logical reason supporting the need to spend excessively.

A significant portion of the companies going public operate in the technology and biotech sectors. In these fields, firms may be unprofitable for years as they invest into customer procurement and R&D. These companies are concerned that if they invest too lightly on acquiring new customers or producing innovative products, they will be unable to gain a competitive footing. On the reverse side, spending at too brisk of a rate means that companies run the risk of cash depletion before they can establish profitability. There can be a fine line between spending that is necessary and spending that is excessive. More firms seem eager to push this boundary, and more investors are willing to take on this risk.

 

The source for this article:

https://www.nytimes.com/2018/05/16/technology/moviepass-economy-startups.html?rref=collection%2Fsectioncollection%2Fbusiness&action=click&contentCollection=business®ion=rank&module=package&version=highlights&contentPlacement=2&pgtype=sectionfront